A home equity loan is when you borrow money using the equity in your home as collateral. That is, you use the portion of your home that's paid for to back the loan.
Example: Let's say you've got a $300,000 home and you still owe $100,000 on your mortgage. That means you've got $200,000 in home equity, and could borrow against a portion of that through a home equity loan.
Because a home equity loan is secured by the value of your home, you could lose the property to foreclosure, the same as if you fail to make the payments on your regular mortgage.
Why choose a Home Equity Loan?
Home equity loan rates are significantly lower than unsecured debts, such as credit cards and personal loans.
There can be tax advantages, as interest on home equity loans is usually tax deductable.
Closing costs on home equity loans are relatively low and in some cases, nonexistent
How to qualify for a home Equity Loan?
To qualify for a home equity loan, you need three things: home equity, credit and income. These all affect each other, so being stronger in one area can offset being weaker in another. For example, a strong credit score may help you qualify despite having limited equity, or vice versa.
You need enough sufficient home equity to both borrow against and leave an adequate cushion afterwards. In practical terms, that means you need to have at least 25-30 percent equity in your home in order to qualify for a home equity loan
A credit score in the mid-600s is usually adequate to qualify for a home equity loan, unless you're borderline on income or equity. A score in the 700s is a safer bet, though it's possible to qualify with a score as low as 620 if other guidelines are met.
On income, what actually matters is your debt-to-income ratio, or the amount of your monthly income required to cover your debt payments, including your mortgage and the new home equity loan. The rule of thumb is that your total monthly debt obligations shouldn't exceed 45 percent of your gross monthly income.
Understanding the different types
Home equity loans come in two types: the standard home equity loan and the home equity line of credit, or HELOC.
With a standard home equity loan, you borrow a certain amount of money and repay it over a specified period of time.
A home equity line of credit, on the other hand, allows you to borrow up to a certain limit as you see fit, in whatever amounts and at whatever times you wish. It's like a credit card, only one that allows you to borrow money instead of charging purchases to it.
Standard home equity loan or HELOC?
A regular home equity loan is useful if you need a lump sum of cash for a particular purpose, such as paying off other, high-interest debts or a one-shot home improvement such as replacing your roof. They're usually set up as fixed-rate home equity loans, so your monthly payments never change and you begin repaying it almost immediately. Loan terms usually run from 5-15 years.
A HELOC is good for an ongoing project where you'll have irregular expenses over time, such starting a business or a home improvement project where you'll be paying for supplies and the work in stages.
HELOCs are divided into a draw period, typically 5-10 years, when you can borrow against your line of credit, and a repayment period when you pay back whatever you've borrowed. They're usually set up as an adjustable-rate, interest-only loan during the draw period, then convert to a fixed-rate home equity loan when the repayment period begins.
HELOCs generally offer the best home equity loan rates, at least initially, because adjustable rates run lower than fixed ones do. However, that can change over time if market rates increase and your HELOC rate rises with them.
With many HELOCs, you can repay loan principle without penalty during the draw period, then borrow again as needed, so it can serve as a reserve pool of funds to use and repay as the situation warrants.
HELOCs tend to have lower up-front fees than standard home equity loans, and may charge no origination fee at all. However, you may have to pay an annual fee for each year the line of credit stays open, regardless of whether you have an outstanding balance or not
Click below for more information on rates and product details.